Guernsey: Initial Token Offerings - Five Things That You Need To Know About Them

Initial token offerings (ITOs), also called initial coin
offerings (ICOs), token launches or token generation events, are
one of the latest trends in financial services. ITOs have emerged
out of the increasing use of distributed ledgers and blockchain
technology, the software that underpins cryptocurrencies, such as
Bitcoin.

However, are ITOs just another buzzword or fad in the Fintech
sector, or are we seeing a new method of investing emerge? In this
article senior associate Stephen Ozanne shares his top five things
that you need to know.

1. WHAT ARE ITOs?

Tokens (or coins) are a virtual form of investment, which have
been created using blockchain technology. Some start-up technology
companies are "issuing" tokens as an alternative means of
raising capital by using an existing blockchain platform, such as
Ethereum, to create and record the distribution of tokens as a form
of investment in the start-up.

The investment terms of the tokens are pre-programmed into the
blockchain to form a "smart contract" that can be
automatically performed by software. For instance, smart contracts
can autonomously transfer tokens to investors once the smart
contract has recognised that all the conditions for investment have
been met (such as transferring the purchase price for the tokens,
usually in a cryptocurrency, to the issuer). A blockchain platform
can securely verify and record transfers of tokens, and should be a
transparent means for investors to monitor their investments
(Bitcoin's open blockchain ledger is publically visible online,
although other blockchain platforms can be private). Since the
administration of the token issue is automated by software, it is
very efficient, and typically only the token issuer and investors
need to participate. This has the potential to disintermediate (cut
out) many of the parties that are typically involved in traditional
forms of issuing investments.

2. WHAT IS THE SIZE OF THE MARKET?

ITOs have become popular for start-up companies in the
cryptocurrency, cloud computing and social media sectors to raise
capital as an alternative to venture capital and initial public
offerings (IPOs). According to Autonomous Research, a financial
analytics firm, start-up technology companies have already raised
over $1.2 billion in 2017 from ICOs and ITOs in over 50 different
businesses and projects. The first notable ICO was in 2014 by
Ethereum, which raised $18.9 million. More recently, Tezos raised
over $208 million from an ICO.

3. WHAT DO INVESTORS GET?

Typically, tokens give investors a right to an interest in the
start-up, similar to traditional forms of investment such as
company shares, and can include rights to a share of profits.
Alternatively, tokens can be used to give investors other rights
and licences to the products or services produced by the
start-up.

4. ARE ITOs REGULATED?

Some ITOs have been promoted as an unregulated form of
investment, relying on the argument that tokens are not a security
for the purposes of the different investor protection laws in
countries around the world. As a result, some token issuers have
used ITOs as a means of avoiding regulation. However, depending on
the nature of an investor's rights that attach to a token, it
is possible that a token is a form of security, particularly if
those rights entitle the investor to a share of the profits of the
token issuer and the investor is not involved in the day-to-day
management and control of the token issuer. This view has recently
been recognised by the US Securities and Exchange Commission (SEC)
in its investigation into the coins issued by The DAO
(decentralised autonomous organisation), which had raised over $150
million from an ICO that the SEC classed as an offer of
securities.

Tokens that give investors other rights, such as licences to
products and services, could fall outside the scope of being
classed as a security. However, token issuers and investors still
need to proceed with caution, because it is possible that those
types of tokens could also be classed as a security, depending on
the facts and circumstances of each case and the investor
protection laws that apply to the tokens. Further, how different
countries want to tax gains made on tokens may also influence how
they are recognised for regulatory purposes.

5. ARE ITOs JUST ANOTHER FINTECH BUZZWORD OR FAD?

Unlikely. Reports suggest that the ITO market grew over 800
percent in past two years, and a further 540 percent during the
past six months, which is staggering. The market is also starting
to diversify to include other types of businesses and projects,
including investment funds. In essence, tokens and coins are the
labels given to the means of granting investors' rights using
blockchain technology, whatever those rights may be. Once
traditional technology and investment firms start using blockchain
technology for making investments, it is likely to quickly become a
common method of investing. In this regard, IBM and the London
Stock Exchange Group have recently announced a joint project to use
IBM's blockchain platform to enable SMEs to more easily offer
securities in the EU. I expect ITOs will be around for the
foreseeable future.

This article first appeared in EnVoyage Magazine.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
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